Principles of Auditing

By Dr. N.Velmathi

While studying B.com, B.com(CA), students are having detailed accounting knowledge.In the final year they are having principles of auditing theory paper which highlights immense job opportunities are available in this field. Auditor work begins when the accountant job ends. After holding a degree in this field students can take up for a job in both private and government sectors.

The purpose of this book is to introduce the student to the fundamental principles and practices of Auditing. It will demonstrate the role, ethics, responsibility and duty of the auditor as well as the purpose, benefits and limitations of auditing. It helps the beginners to Understand audit processes from the planning stage to the reporting stage.

• Language: English
• Publisher: Pustaka Digital Media
• Release date: Apr 16, 2024
• ISBN: 6580577710922

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Principles of Auditing

Author:

Dr. N.Velmathi

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https://www.pustaka.co.in/home/author/dr-nvelmathi

Table of Contents

ACKNOWLEDGEMENT

Preface

Introduction

Definition of Auditing

Audit Programme

Internal Control

VOUCHING

Audit Note Book

Depreciation

Reserves and Provisions

Provisions

Valuation and Verification of Assets and Liabilities

Auditor of a company

Liabilities of an Auditor

Share capital

Auditor’s Report

Kinds of Audit Report

Investigation

Electronic auditing

Choose the best

ACKNOWLEDGEMENT

Iexpress my heartfelt gratitude to God Almighty whose blessings guided me in writing this book successfully.

I prime thanks to my husband Mr.S.Palanivel, M.A., B.ed., M.Phil., B.T. Assistant English, ManimekalaiElango Higher Secondary School, Devathur, My father Mr. P. Nachimuthu, My mother Mrs. N. Malarvizhi and my Son P. V. Hariram who always encouraged me to write this book.

I owe thanks to Sri. C.M.N. Muruganandan, Chairman, Sri. R. R. Shrinivasan, Academic Chairman, Sri. T.R. Vijayakumar, Chairman- Admission and Governing council members of NIFT-TEA College of Knitwear Fashion, Dr. K.P. Balakrishnan, Principal, NIFT-TEA College of Knitwear Fashion, my dear colleagues and others who have helped me in this work.

My heartfelt thanks to Dr. A. Arunachalam, M.A., M.Phil., Ph.D., Reader in English (Retired), Erode Arts College (Autonomous), Erode who always motivated me to write this book.

I express my sincere gratitude to Dr. M.G. Saravanaraj, Professor,Department of Management Studies, Mahendra Engineering College, Tiruchengode and Dr. S. sumathi, Director, Department of Management Studies, AVS Engineering College, Salem. Who have shown their keen interest, encourage and co-operation in the publication of the book.

I express my special thanks to My brother Dr. N. Pasupathi, Director, Parks College(Autonomous), Tirupur who has contributed a great deal for my success as an author of this book.

Last but not least, my sincere thanks to Mr.Natarajan, Editor,PallaviPathippakam and Kongunadu publications which published this book.

Preface

Personally, I am interested to ‘study’ and teach the subject Principles of Auditing. This was because of the reason that this subject is the most practical subject besides Accounts & Taxation.

While studying B.com, B.com(CA), students are having detailed accounting knowledge. In the final year they are having principles of auditing theory paper which highlights immense job opportunities are available in this field. Auditor work begins when accountant job ends. After holding a degree in this field students can take up for a job in both private and government sectors.

The purpose of this book is to introduce the student to the fundamental principles and practices of Auditing. It will demonstrate role, ethics, responsibility and duty of the auditor as well as the purpose, benefits and limitations of auditing. It helps the beginners to Understand audit processes from the planning stage to the reporting stage.

Introduction

The word Audit is derived from the Latin word audire which means to hear. In the olden time whenever the owners of a business suspected fraud, they appointed certain persons to check the accounts. Such persons sent for the accountants and heard whatever they had to say in connection with accounts.

The original object of an audit was to see whether the accounting party has properly accounted for the receipts and payments of cash. In other words the object of audit was to find out whether cash has been embezzled and, if so, who embezzled it and what amount was involved. The object of modern audit is to see whether the balance sheet exhibits a true and fair view of the state of affairs of a company and whether it is drawn up according to the Companies Act, in the case of the audit of a company.

Definition of Auditing

The Institute of Chartered Accountants of India in its publication of Auditing and Assurance Standard (AAS 1): Basic principles Governing an Audit (AAS 1) describes audit as " the independent examination of financial information of any entity, whether profit oriented or not, and irrespective of its size or legal form, when such examination is conducted with a view to expressing an opinion thereon.

Objectives of an Audit

The Auditing and Assurance Standard: objectives and scope of Audit of financial statements-AAS 2" of the Institute of Chartered Accountants of India specifies that the objective of an audit is to express an opinion on financial statements. To give the opinion about the financial statements, the auditor examines the financial statements to satisfy himself about the truth and fairness of audit examination.

The objectives of audit can be categorized into i) Main objectives ii) Secondary objectives and specific objectives

The main objective of audit is to express expert opinion on financial statements. The secondary objectives are i) detection and prevention of errors and ii) detection and prevention of frauds.

I. Main Objective

Expression of expert opinion:

A business entity prepares profit and loss account and balance sheet to portray its financial position. The auditor checks them in a careful manner with utmost diligence and professional competence. He verifies that the accounts are prepared within the framework of recognised accounting policies and practices and relevant statutory requirements if any. He checks whether the facts as represented in the balance sheet and profit and loss account are true. Based on his checking in these respects, the auditor expresses his opinion about the quality of the financial statements concerning proper disclosure of facts in the financial statements and the truth and fairness of the financial position and operating results of the enterprise.

II Specific Objective

Errors are generally innocent but sometimes errors which might appear, at first sight, as innocent are ultimately found to be due to fraudulent manipulation and therefore an auditor must pay particular attention to every error, however, innocent it may appear to be at first sight. There are various types of errors

1.Clerical Errors. These errors are committed in posting, totalling and balancing. Such errors may again be subdivided into –

a) Errors of Omission

The error of omission is one where a transaction has not been recorded in the books of account either wholly or partially. In the former case it will not be easy to detect the error and it will not affect the trial balance. E.g., the rent account may show that the rent for the 12th month has not been paid. This type of error can be detected by careful observation. Similarly purchase and sales have entirely been omitted to be entered, which have found out by vouching of purchases and checking stock book will show this type of error. It is a method by which goods as well as cash is misappropriated.

b) Errors of Commission

When a transaction has been recorded but has been wrongly entered in the books of original entry or posted in the ledger, error of commission is said to have been made. E.g. a purchase invoice for Rs1250 was entered in the purchase book as Rs.1520. Such error may be intentional or un-intentional. Wrong castings, calculations, postings, extensions, carry forwards etc. are included in this type. Therefore, vouching should be done carefully, in order to detect such as error or fraud.

2. Error of Principle

Such errors arise when the entries are not recorded according to the fundamental principles of accountancy. E.g. wrong allocation of expenditure between capital and revenue, ignoring the outstanding assets and liabilities, valuation of assets against the principles of book-keeping etc. such errors may be committed either intentionally or unintentionally. If they are committed intentionally, the object is to falsify and manipulate the accounts either to show more profits or less profits than they actually are. Such errors are not disclosed by the trial balance or by routine checking. It can be detected only by a searching inquiry and independent checking.

3. Error of duplication

Errors arise when an entry in a book of original entry has been made twice and has also been posted twice.

4. Compensating errors or off-setting errors

A compensating error is one which is counter-balanced by any other error. If purchase of goods from Ram is Rs1000, but Rs.100 was credited to Ram while goods purchased from Ravi Rs.100 but was credited to Rs.1000. thus both accounts have been credited a total sum of Rs.1100 which amount ought to have been debited to purchase account. Again over-casting of an account may be counter-balanced by the under-casing of another account to the same extent. This type of error will not be detected by the trial balance. This error may or may not affect the profit and loss account.

Location of errors

The following steps are easy to locate an error without any difficulty

1. Check the totals of the trial balance

2. Compare the names of the accounts in the ledger with the names of the accounts as have been recorded in the trial balance.

3. Total the lists of debtors and creditors and compare them with the trial balance

4. If the books are maintained on the self-balancing system; see that the total of different accounts agrees with the total of these accounts with the balance of accounts as recorded in the trial balance.

5. Compare the items of the trial balance with the items of the trial balance of the previous year to see if any item has been omitted.

6. Whatever be the difference in the trial balance, halve it and see if there is any item of this value. This is done to avoid the putting of the debit balance on the credit balance of the trial balance and vice versa

7. It is possible that the totals of some subsidiary books e.g., cash book, purchase book, sales book etc might not have been transferred to the trial balance. Re-check the totals of these books.

If in spite of the above steps the error cannot be located the error may be due to the following causes

1. An error say of Rs1 or 10 or 100 etc. i.e., a round sum may be due to wrong totalling. If the difference is in rupees and paise, it may be due to wrong posting or extracting wrong balance.

2. An error which is divisible by 9 may be due to misplacement of figures e.g., 23 for 32, 52 for 25 and so on.

It may be remembered that in spite of the fact that the trial balance has agreed, it does not mean that there are no errors.

II. Detection and Prevention of Fraud

Fraud means false representation or entry made intentionally or without belief in its truth with a view to defraud somebody. Detection of fraud is considered to be one of the important duties of an auditor. Originally audit was conducted with a view to detect fraud whenever it was suspected. The system of internal check aims at the prevention of fraud. If he finds that the internal check system is defective and will not prevent the commission of frauds, he should suggest a better system. The following are the chief ways in which fraud may be perpetrated:

1. Embezzlement of cash

2. Misappropriation of goods and

3. Fraudulent manipulation of accounts

Embezzlement of cash

Cash may be misappropriated by

a) omitting to enter any cash which has been received; or

b) entering less amount than what has been actually received; or

c) making fictitious entries on the payment side of the cash book; or

d) entering more amount on the payment side of the cash book than what has been actually paid.

In order to discover fraud under (a) and (b), the auditor should check the debit side of the cash book with rough cash book, salesmen’s reports, counterfoils of the receipt books, agents returns and other original records while the fraud under (c) and (d) can be discovered by reference to the vouchers, wage sheets, salary book, invoice etc.

Misappropriation of goods

Again fraud may be in respect of goods. Proper methods of keeping accounts in regard to purchases and sales, stock taking, periodical checking of stocks, comparing the percentage of gross profits to sales of two periods, necessity for collusion will help to avoid misappropriation of goods.

Fraudulent manipulation of Accounts

This type of fraud is more difficult to discover as it is usually committed by directors or managers or other responsible officials with the object of

* Showing more profits than what actually they are a) so that if they got commission on profits, that they get more commission; or b) their service may be retained by showing to the shareholders that because of their efficiency they have shown more profits and thus maintain the confidence of the shareholders or c) if they hold shares, they may sell them at high price by declaring higher dividends; or d) obtain further credit by showing the financial position of the business better than what actually it is; or e) to attract more subscribers for the sale of the shares of the company, etc. or

* Showing less profits than what actually they are i) in order to purchase shares in the market at a lower price; or ii) to reduce or avoid the payment of income tax; or iii) to give wrong impression about the success of the business to competitors, etc.

* Falsification of accounts may be resorted to

i) By not providing depreciation or providing less depreciation or providing more depreciation; or

ii) By under-valuation or over-calculation of assets and liabilities; or

iii) By showing fictitious sales or purchases or returns in order to show more profits or less profits